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The Archegos explosion raises tough questions for Wall Street

The Archegos explosion raises tough questions for Wall Street


It is still unclear where Archegos Capital is in the explosion of spectacular hedge funds. But the initial signs are likely to prove that it will be the largest since the fall in long-term capital management in 1998.

The saga opened last Friday when Goldman Sachs and Morgan Stanley began breaking coverage and throwing billions of dollars into shares of US and Chinese stocks. The failed “margin call” was made in the name of an unnamed investment fund, essentially a demand to put more collateral against its trades or to face a forced liquidation.

This sparked a tremendous epic upheaval in the markets, along with the Archegos. Bill Hwang is a dark and remarkably opaque investment group led by a former manager of the Tiger Management hedge fund in the past. By Monday, Credit Suisse and Nomura admitted they would likely lose billions of dollars in the falls.

At this early stage, there are still many more questions than answers. Here are some of the most urgent ones.

First: what were some of the world’s largest investment banks thinking when they opted for an opaque family office, as the founders had a history of regulatory problems, with a multimillion-dollar advantage? Hwang was fined $ 44 million Settle on illegal U.S. trade rates In 2012, and in 2014, he was banned from trading in Hong Kong.

True, the fact that Archegos serves as a family office means that he was exempt from many of the regulatory appearances required in hedge funds. But the banks seem to have failed the processes of knowing the key “clients” that cover the main brokerage boards – the research that covers the funds, the commercial structuring and the leverage.

Each bank may feel comfortable with exposure to Archegos, assuming that they can always allow their positions to cover themselves. But they didn’t realize that if everyone had to throw away the value of tens of billions of shares, the guarantees they could include in their contracts would be completely inadequate.

In the infamous explosion of the LTCM in 1998, the fund took advantage of Wall Street’s hunger to bank against each other and get into the big lever of each of them – often unaware of the real exposure of opponents.

But at least LTCM was the largest hedge fund in the world at the time, created by renowned Salomon Brothers traders and advised by Nobel laureates. Archegos ’underestimated and obscured size – and probably the thick fees they paid to major brokers – were not the fund and Hwang was essentially a Wall Street entity.

This leads us to another question: what exactly is Archegos Capital? The size and leverage of his positions would be extreme for one of the most aggressive members of the hedge fund industry, let alone a family office. In fact, it looks like a Reddit day trader got access to a Goldman Sachs credit card and it looks like the bananas are gone.

Prime brokers have estimated that he managed about $ 10 billion before the disaster began, which is a lot for the family office of someone who was almost titanic in the hedge fund industry.

Historically, family offices did not have to register with the Securities and Exchange Commission, which is the exception for companies with 15 or fewer customers. The Dodd-Frank Act, which tightened regulations as a result of the 2008 financial crisis, removed this exception to give more light to the hedge fund industry. However, the SEC has left the family offices decide for themselves to be registered and to submit regular reports.

Given its size, does Archego manage the money from people other than Hwang, and if so, should more information be made available to the SEC?

Archive search in the SEC “Edgar“The reporting system provides almost nothing, striking in itself. The use of financial derivatives known as swaps to obtain positions would avoid the requirements for reporting large holdings.

So far investment banks have had about $ 20 billion in stock sales, but analysts say there could be more. How much more though? Estimates vary dramatically. Are there any other funds that are being liquidated by force, as Archegos is only the first to be identified?

Last but not least: can the fall of Archegos cause more widespread financial pollution, as the LTCM did two decades ago?

Luckily, the answer is probably not – with a few remarks. The LTCM was much larger, with the texture of several markets that were systematically important, and its downfall could have brought down several major banks if the authorities had not organized a bailout and coordinated its disbandment. Archegos ’losses will be humiliating for many banks, and in some cases will ruin their year, but they have capitalized much better since 2008.

That said, there is a high risk that a mistake of this size will drive the entire investment banking industry to leverage the amount of leverage it offers to its hedge fund clients. If so, then the forced liquidation of an isolated gung-ho investment group can turn into a snowball that causes a wider hedge fund not to load. For now, the markets are taking the misfortune for granted, but that could change.

robin.wigglesworth@ft.com

Twitter: @robinwigg



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